Pandora banks on advertising over music sales

CEO Joe Kennedy on monetization of the personalized Internet radio station

Just this month, the Senate passed a bill extending the time for Internet radio stations and music owners to agree on royalty payments. It's now up to President Obama to sign this bill. At stake is millions of dollars that can make or break the leading Internet radio station, Pandora. While Pandora expects to rake in $40 million in sales this year, double last year, more than half is expected to go toward royalty payments.

Currently, Pandora pays 3 cents per listener per hour, said CEO Joe Kennedy. But he expects the RIAA (Recording Industry Association of America) - which has historically pushed for higher fees - won't prevail in driving them higher. 

In this second part of a three-part interview with Kennedy, we not only cover the topic of royalty fees, but what's going to drive revenue for Pandora to cover that immense cost. Traditional radio stations typically play 16 audio ads in one hour of listening time! Kennedy said Pandora plans to expand audio ads, but they'll never reach 16 in an hour. And, while Pandora is selling $1 million in monthly music sales, Kennedy says it's advertising on mobile and the Web that will be the driving force. 

Here's our interview, partly edited. At the time, Pandora was not developing a service on Android. In an email update, Kennedy said Pandora is releasing this service "as soon as possible." Additionally, Kennedy said Pandora has now reached six million iPhone activations, and 1.5 million Blackberry activations. This is up 20% and 50%, respectively, from activations just one month ago. 

BF: We are continuing our discussion about Pandora's mobile strategy and how it is monetizing its mobile Web content. When are people listening to their iPhone app? Are they in their cars or work? What is the usage like?

JK: The iPhone is unlike Internet radio which is very much like an "at work" kind of thing. The iPhone is like  coming into work, at home, or on the weekend. It is the complete opposite. Twenty five percent of our users tell us they are listening in the car. The other thing that's unique is that you can use an iPod docker for your iPhone and there is a lot of listening over WiFi in the home. So there is very diverse usage.

BF: And you're generating one million dollars on monthly music sales. Twenty percent coming from the iPhone, so it's doing really well.

JK: It's really accelerating with the iPhone. We've always done a growing amount of music sales which we love because it supports the people who create the music on the site. But we've just noticed that we're doing a million dollars a month in music sales. The iPhone has been a tremendous catalyst for that and it seems like the ability to be listening to a song and to buy it immediately to download the device that is more of an owned music collection that you walk around with. That's  a real winning combination.

BF: So on the iPhone, you make $200,000 from music sales. Is that the bulk of the business? Or is it the advertising on the iPhone?

JK: $200,000 is what we sell. And, our piece of that is typically five and 10 percent depending on whether it's Amazon or iTunes. In the total revenue standpoint, it is actually a small part of the picture. But great benefit to our listeners and great benefit to the people who create the music.

BF: But you're doing more in advertising? How much?

JK: So we did $20 million in revenue last year and we have a shot of doubling that this year. By contrast, if you take 5% or 10% of a million in monthly music sales, that's $5,000 or $10,000 dollars a month.

BF: Is the doubling growth that you mentioned earlier coming from iPhones? Is that going to come from iPhone advertising or iPhone music sales?

JK: Mobile advertising on the iPhone or Blackberry, soon to be on the Palm, is one of the catalysts for our growth in terms of ad revenue this year but a big part of the growth is more of Web advertising.

BF: That's interesting. So more of the Web than mobile. You're doing a lot in terms of driving a lot of sales to iTunes and that is great service to your users. Is Pandora an iTunes discovery engine or is it a radio station? Do you see people using it more to listen to music on the mobile device or do you see it as a way for them to discover music to buy?

JK: At our core, we view it as a radio experience. It's a wonderful, serendipitous, journey through your favorite part of music universe. That said, radio is a discovery engine. Think about the songs you own and the songs you've bought over the course of your life, probably the majority of them you've heard the first time on the radio. We view that as part of the radio experience. You are driving down the road and you hear a great song and now you can learn everything about the artist, lyrics, and you can even buy the song on the spot and with an iPhone you can buy it right on your mobile device.

BF: In the last interview, we talked about how people are listening to this stuff while driving so it's hard for people to actually look at the device and radio stations typically have 16 advertiser spots and that is why they can make money through advertising. Is this some thing you can implement into the Pandora experience?

JK: I can never see 10 or 16 audio ads an hour. I think we have to work with a smaller set of ads shorter in length. But we need to recognize that because we are connected, those ads can be more targeted, interactive, and there are a variety of ways, and those ads are trackable. And, by virtue of those characteristics, create more value for advertisers.

BF: One last question regarding what you have to pay out in the industry. Where are royalty fees going? You mentioned that you are paying $0.03 per listener per hour. Do you see them stable in 2009? What is your argument for keeping them $.03 or below?

JK: The final rates are still being worked out through this extraordinary process but we're optimistic that a reasonable solution will be reached. It will be a number less than 3 cents but it will be a significant number. We'll pay tens of millions of dollars in royalties. It is by far our most significant cost. This is one of those things where it needs to be the right amount. The good news is that the recording industry, Pandora, and many other people in the Web casting industry seem to be close to sorting out the differences.

BF: Will your royalty fees account for 70% of your revenue this year?

JK: I wouldn't put a specific number on it. I don't think it's going to be as bad as 70% (that order of magnitude last year), but it'll be our biggest cost.

BF: In a couple of years, where do you see the majority of your sales? Is it going to come from mobile or the Web?

JK: I think over time, that's going to become an interesting story. Historically, radio is something that is listened to in the home or the car. Radio has 80% of radio listening which would point to mobile devices, automotive installation integrations, and home consumer electronic devices as ultimately becoming the biggest delivering mechanism for Pandora. I think the question is how long will it take to get there and listening at work or in an office has grown enormously with the Internet radio. What we're seeing at this point though is fantastic growth in all forms of delivery of Pandora which is great.

BF: Joe, we wish you the best of luck.